10 tax and reporting considerations for U.S. taxpayers with foreign ties
As the 2023 tax season gets underway for the 2022 tax year, individuals and businesses with foreign tax connections have extra considerations to keep in mind.
Although no significant U.S. tax laws came into effect for international businesses in the 2022 tax year, reporting requirements have become more complicated in recent years as the U.S. seeks to capture additional tax revenue from international companies and transactions.
The following are a few considerations to keep in mind for international tax planning this tax season.
1. Understand how an acquisition or company structure characterization can impact taxes
Any time a foreign individual or company purchases an interest in a U.S. company or U.S. real estate, U.S. tax implications should be considered when structuring the U.S. company or real estate acquisition. Income taxes are a primary consideration, but individuals will also want to consider U.S. estate tax implications, and work with their advisors to balance both types of taxes.
Real estate transactions require special considerations, especially for foreigners selling U.S. real estate. For example, the Foreign Investment Real Property Tax Act (FIRPTA) aims to ensure that foreign individuals or companies pay U.S. taxes when they dispose of U.S. real property. The buyer is responsible for collecting taxes on such sales and remitting the funds to the IRS.
Under FIRPTA rules, 15% of the proceeds from real estate sales by foreigners are withheld as a tax. However, the exact definition of “proceeds” can vary based on how the transaction is characterized under IRS rules. Such disposition may be characterized as sales, transfers, gifts, redemptions or liquidations. The structure of the purchase can change the characterization of the transaction, which can, in turn, change the tax implications.
Another consideration for real estate owners is cost segregation to accelerate depreciation on real estate assets. Cost segregation requires completion of a study, which must be done prior to the submission of any tax returns.
If possible, consult with an international tax professional during the earliest stages of any international acquisition or sale. A professional with international tax experience can help you understand the best way to structure and characterize any acquisition or sale to minimize the tax consequences.
2. Report dividends for tax purposes
Payment of dividends to foreign shareholder individuals are subject to certain U.S. tax withholding rules, and may create a dual layer of U.S. tax obligation: In addition to a corporate tax on the profits, the individual may be subject to income tax on the dividend. The dividend tax may be reduced by tax treaties for some foreign individuals.
3. Update transfer pricing studies
U.S. tax law provides that companies that conduct transactions with foreign subsidiaries require contemporaneous transfer pricing studies to demonstrate these transactions are priced “at arm’s length.” These studies should be done before the transaction occurs, rather than after the fact. While companies generally only need to provide the study to the IRS during an audit, studies need to be updated regularly. With the past year’s inflation, many companies will need updated transfer pricing studies.
4. Complete filing and withholding for intercompany funds transfers or loans
Companies with subsidiaries should pay attention to intercompany transfers or capital contributions because they may be taxable.
In some situations, transfers of money between related companies may be classified as intercompany loans; doing so requires specific legal documentation, and the company receiving the money must pay interest.
Most companies that pay interest to a foreign lender – including a parent or subsidiary company – are subject to withholding requirements. There are some exemptions to the withholding requirements for portfolio companies when a foreign entity lends money to a related U.S. company. In addition, transfer of funds by a U.S. company to a foreign subsidiary triggers certain filing requirements.
Consider engaging a U.S. tax advisor with international tax experience to help you follow filing and withholding requirements.
5. Review payments to foreign consultants
Businesses that pay foreign external consultants must comply with requirements related to documentation, filing and tax withholding. This is a good time to review records of any such payments, including confirming that consultants are properly classified as foreign or domestic tax residents and confirming that you have up-to-date W9s and W8 Series forms.
Many companies forget or mistakenly overlook the required withholding and/or filings, which can lead to penalties.
6. Global intangible low-taxed income (GILTI) may apply to your U.S. company
IRS rules surrounding global intangible low-taxed income (GILTI) have made many U.S. persons subject to U.S. tax when they previously were not. This is currently a GILTI tax imposed on profits of qualified foreign affiliates of U.S. companies. The effective tax rate on foreign profits are 10.5% for a U.S. corporation but can be higher for non-corporate taxpayers, however, and recent regulations provide for profits taxed above 18.9% to be exempt from the minimum tax.
7. Individuals: Understand whether you have international tax connections
If you are a foreigner with a business or real estate ownership in the U.S., or spent more than a few weeks in the country, you may be subject to U.S. income tax – even if you’re not a U.S. citizen or green card holder. Nonresidents may be subject to U.S. income taxes if they meet the “substantial presence” test in any given year, meaning they spent at least 31 days in the U.S. during the tax year, as well as a total of 183 days during a 3-year period.
U.S. citizens, residents and those considered U.S. persons for tax purposes are taxed on their worldwide income. If you fall into any of these categories, you must report your worldwide financial interests, including certain interests in foreign trusts.
Your tax professional can help you understand whether you’re a U.S. person, as well as which interests you must report and which you must pay taxes on.
8. Individuals: If needed, request an Individual Taxpayer Identification Number (ITIN)
An ITIN (Individual Taxpayer Identification Number) is a federal tax processing number provided by the IRS to foreign individuals who do not qualify for Social Security Numbers. ITINs are used for reporting rental and other U.S. taxable income, filing federal income tax returns and applying for tax refunds. Most foreign persons doing business in the U.S. require an ITIN, and many do not realize this.
The process of obtaining an ITIN can be complicated, and it generally takes several months (or longer). If you do not have a Social Security number or an ITIN, talk with a tax professional who has international experience as soon as possible. If you require an ITIN, your professional can guide you in and monitor the process, as well as stay connected with the IRS to address questions and determine the status of the application process. While tax reporting and filing can begin without an ITIN, paperwork is more likely to be lost and delayed without one.
Not all foreign individuals with U.S. tax responsibility must have a Social Security number or ITIN. For example, individuals who claim the benefits of certain tax treaties may not require either number.
9. Future international tax considerations
The Corporate Transparency Act, enacted in 2021, requires reporting of an ultimate beneficial owner (UBO) by any entity organized in the U.S. and owned (wholly or partially) by an individual, individuals or company. The requirement will go into effect as of January 1, 2024, and final reporting requirements were released in October 2022.
In addition to ultimate beneficial ownership reporting, companies should also be aware that a global minimum corporate tax rate is supposed to be finalized during 2023. The U.S. is among the more than 135 countries that have signed an agreement that aims to require large companies to pay a minimum tax rate of 15%. The goal is to discourage shifting of profits and tax revenues to low-tax countries. The U.S. hasn’t yet passed legislation to implement this agreement, but that could change in the future.
10. Keep in regular contact with your advisors
Foreign investors and companies may not realize the potential for U.S. tax-related obligations, and U.S. companies that have recently expanded internationally may not have a handle on all the required filings, withholdings and taxes. An international tax professional can help you identify and find solutions to any potential issues that might affect your business, corporate or individual taxes, and any transactions you’re considering or that are in progress.
An advisor can also help you stay up to date with any recent tax changes, such as new guidance on Schedules K-2 and K-3, which provides some relief to certain taxpayers with regards to filing the form.
Contact Kaufman Rossin’s international tax team for help with understanding your international tax obligations and opportunities.
Carlos A. Somoza, JD, LL.M., is a International Tax Principal at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S.
Maria Toledo, CPA, MST, is a International Tax Principal at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S.